Gold trade: banks smarter than you think

JOHANNESBURG – In the past it has been said that central banks were the worst when it comes to trading in gold. No so anymore, specifically since end-2012.

According to the World Gold Council’s recently released data central banks’ gold purchases in aggregate averaged around 150 tons per quarter since 2012.

What is important though is that the central banks are highly price sensitive and do not chase the market. They reduce their purchases when the gold price rise and, conversely, increase their holdings when the gold price falls. The result is that they effectively create a floor for the gold price as they act as buyer of last resort.

The price of gold is mostly watched and quoted in US dollars and the underlying trend is therefore blurred by the strength or weakness of the greenback against other currencies.

In order to get a more balanced view of the global price of gold I calculate a weighted gold price index by using the official index of the dollar against other currencies to calculate a gold price index for the world excluding the US. After indexing the gold price in US dollars both indexes are equally weighted to establish a world price of gold.

But who are the main players?

Twenty-seven of the top 41 countries with the highest official gold holdings were inactive over the past 7 quarters as their gold holding were virtually unchanged over the period.

The BRICS countries and specifically China, Russia and India are the main players among central banks in the market. Since 2012 the 3 countries were responsible for 53 percent of gold purchased by central banks and in the past 7 quarters their share was 50 percent.

The Peoples Republic of China’s official gold holdings increased by nearly 80 percent or 830 tons since 2012 and accounted for 21 percent of all net central bank purchases since the final quarter of 2012.

Over the past 7 quarters the Chinese central bank’s official holdings increased by 43 tons.

The Russian Federation’s official gold holdings increased by 126 percent or 1210 tons since 2012 and accounted for 31 percent of all the central bank accumulation of gold since 2012. Of particular significance is that Russia’s gold reserves ballooned by more than 452 tons since June 2017 implying that they nearly bought all of Russia’s gold production.

India’s gold holdings increased by 9 percent or 51 tons over the since June 2017 and has the 11th highest gold holdings in the world.

Other major players include Kazakhstan whose official gold reserves increased nearly 3 fold since 2012 and it seems that all the gold they produce directly goes into the central bank’s reserve.

What is behind the purchases by China, Russia, India and Kazakhstan? The gold component of the US’s total gold and forex reserves is 75 percent while countries in the EU on average hold more than 60 percent of their reserves in gold.

Russia, the world’s third-largest gold producer, has upped its gold holdings to 19 percent of total reserves from 17 percent in the June quarter of 2017 while China’s gold holdings remained at 2 percent of total reserves.

India’s gold holdings was also unchanged at 6 percent of total reserves. Kazakhstan, on the other hand, increased its gold component to 56 percent of the country’s total gold and forex reserves from 37 percent in the second quarter of 2017.

The bullish case for gold in the long run is that Russia, China and India are likely to continue to increase their gold holdings. To double Russia’s gold holdings to 38 percent from 19 percent currently will take-up 62 percent of current total annual mine production.

In the case of China an increase to 4 percent from 2 percent currently will amount to 54 percent of total mine production.

In the case of Kazakhstan it seems that the country may be targeting a gold component of between 70 percent (as in the case of Germany) and 75 percent (as in the case of the US).

In light of Kazakhstan’s annual gold production the target can be met within a year or two, resulting in reduced overall central bank purchases and additional supply to the open market of more than 70 tons per year subsequently. The additional supply will have a muted impact on the gold price given the pent up demand from Russia, China and India combined.

Also bear in mind that the China, Russia and Kazakhstan together produce nearly a quarter of the world’s newly-mined gold. The gold price will rocket if they decide to withhold production from the market for some or other reason.

But why do central banks hold gold? In 2018, the World Gold Council, in cooperation with YouGov, conducted a survey among central banks to better understand how they manage their gold reserves.

The three most relevant reasons why they invest in gold are gold’s role as a safe haven and as an effective portfolio diversifier. Gold is also universally accepted.

Speculative demand is event-driven and will continue to dictate the short-term movements in the gold price. That is the very reason why gold has historically proven its value in the risk-off investment strategies.

What do the Chinese, Russian, Indian and Kazakhstani central bankers know what we don’t? The gold price has yet to move amid the renewed uncertainties in regard to the Sino/US trade war. Watch the space!

Ryk de Klerk is an independent analyst at large. Contact rdek@iafrica.com). His views expressed above are his own. You should consult your broker and/or investment advisor for advice.